Covestor

Facebook, the mini-musical, and the latest linkfest

Michael Tarsala — Wed, 16 May 2012 16:34:28 +0000

by Michael Tarsala

Markets are in flux. Perhaps the world's most popular trade -- gold -- is breaking down. Volatility is near levels not seen since January.

Yet the hottest markets story, by far, remains the Facebook IPO.

In case you've been under a rock, this mini-musical will get you up to speed:

And here's a best-of selection of Facebook posts from around the blogosphere:

Facebook is getting worse, not better (Business Insider)

The company attracts children and retirees, but not advertisers (Dealbreaker)

Think about this before you buy (Covestor)

The company will roll on, even though GM just pulled its ads (ReadWriteWeb)

Why GM unfriended Facebook (Breakout)

Valuation is fair if the company can monetize with another business model (Chris Dixon)

Insiders are cashing out (WSJ)

Google exec takes a shot at Google's ad biz (Business Insider)

Company could learn from RenRen's margin mistakes (Motley Fool)

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.

BofA analysts see a storm, then sun

Michael Tarsala — Wed, 16 May 2012 15:50:46 +0000

by Michael Tarsala, CMT

The latest market analysis from BofA sees dark clouds, a storm, then the likelihood of a summer rally.

The latest from its technical team calls for a stock correction to the 1,250 to 1,300 range on the S&P 500, although the team recommends buying dips. You can read more here.

Source: Stockcharts.com

What I like about the BofA analysis is that it doesn't throw out hard-and-fast numbers. It allows for the fact that support and resistance can be in ranges.

Their call makes use of Ichimoku clouds. You can learn all about them at Stockcharts.com. In the chart above, you see them as the green shaded area, and they reflect expected price support zones. As you can see, the support zone has been broken in recent days.

What happens next? Well, the 1,250 to 1,300 area is a very sensible place for the market to head next. It's precisely in line with the next big volume support level, marked by the long pink bars that come from the left of the chart. The longer they are, the stronger the support. And 1,250 to 1,300 provides just a little wiggle room on either side of the lines I marked in black.

If things play out the way the chart above (and BofA) suggests, long-short models, swing trading strategies, and money managers who will scale into risk-on trades as the market makes a turn all could be a viable options.

Talk to us if you would like to learn more about our unique Covestor models, or to discuss your investing goals with one of our experts.

Big-name strategists who zig when others zag

Michael Tarsala — Wed, 16 May 2012 14:00:19 +0000

by Michael Tarsala

Josh Brown, The Reformed Broker, has a cool chart today that lends even more support to the argument that extreme pessimism is a reason for stock market optimism:

The line in blue is the recommended stock weighting of stock strategists polled weekly by Bloomberg. As you can see, it's at 52%, not too far above recommended weightings when the stock market started rocketing higher off the bottom in March 2009.

Source: The Reformed Broker (via Bloomberg and Bespoke Investment Group)

Not all are so pessimistic, though. Some are zigging when others are zagging.

Check the latest from Liz Ann Sonders at Schwab, who thinks a summer rally could be in store.

And here is the latest from Wells Fargo's Stuart Freeman and Scott Wren:

Two things really stand out to me about what these guys are saying.

Source: Stockcharts.com

They have an overweight rating (5%) on the highly cyclical materials group -- a group that most strategists hate right now.

Above is a proxy for that sector, the Materials Select Sector SPDR (XLB). You'll see no reason to suspect an immediate turnaround. However, the selloff is on fairly low volume. Also, there is strong volume support (represented by the pink bars at left) at around $33, about a point lower than where it's trading.

One other surprise is that Wells has a zero holding recommendation in utilities -- the defensive group that the market now loves.

Source: Stockcharts.com

Above is the chart of the Utilities Select SPDR (XLU). There's nothing to suggest this uptrend is in jeopardy. To the contrary, there's reason to think it will break higher from recent consolidation.

What's possible, though is that there will be an eventual shift back to risk-on trading -- perhaps this summer, as Sonders suggests.

So in time, the cyclical groups such as materials could again begin to outperform the defensive plays (such as utilities).

Contact us if you would like to discuss strategy, or about model managers who fit your style and are planning for the next big sector shifts.

The market remains in a positive trend, despite turbulence

Mark Holder — Wed, 16 May 2012 13:22:18 +0000

Author: Mark Holder, Stone Fox Capital

Covestor model: Net Payout Yields

This model gained a solid 0.8% in April versus a 0.7% loss for the benchmark S&P 500. The model remained strong all month even as the S&P 500 Index (SPX) fluctuated all month. No trades were made in the month of April as existing positions continued to work well with high yields.

Considering the market was slightly down and the model was only slightly up, not many positions had outside moves. The biggest gainers were Gap (GPS), Travelers (TRV) and Chubb (CB).

All three companies had very strong earnings partially helped out by the large buyback programs over the last year.

Just as with the top performers, not many stocks had outside negative moves in the month. The biggest losers were Conoco Phillips (COP), Goldman Sachs (GS) and WellPoint (WLP) with all three companies losing more than 5%.

Conoco Phillips had disappointing earnings that naturally pushed down the stock. The other two had surprisingly good earnings even though the stocks sold off.

A couple of corporate transactions took place by the first of May that impacted stocks in the model.

Conoco Phillips decided to spin off the downstream business into a new entity called Phillips 66 (PSX). Since the spin off split the full position into two smaller positions, the two stocks will be reviewed as to whether to add to or eliminate the positions.

It all depends on whether the new independent companies will continue supporting high yields. The initial suggestion is that Conoco Phillips will keep the current 4.9% dividend yield while Phillips 66 will only start with a 2.5% yield. The level of buybacks will be crucial as to whether each stock remains in the model.

During April, Medco Health (MHS) was bought by Express Scripts (ESRX). The deal involved partial stock so the model is now invested in roughly a half position in Express Scripts. At this point it is unclear whether the combined companies will continue supporting large buybacks to justify remaining in this model.

The market in general remains in an uptrend that likely will lead to multi-year highs though it has come under pressure as May began. This model will remain fully invested to capture as much upside as possible while protecting against any major downside from owning solid large cap stocks with outsized yields.

The biggest concern to this model remains that end of year tax hikes to dividends will hurt those stocks as 2012 ends. The issue and impact to the markets is now being debated on a regular basis, but the outcome remains very much in question.

As May proceeds, the model should be expected to rebalance some of the positions from the corporate transactions mentioned above as the details become clearer. The model prefers to limit transactions to reduce costs as the companies invested in are solid with or without high net payout yields. Though if it becomes apparent that going forward yields will not support inclusion in this model, the stocks will be sold for higher paying alternatives.

Portfolio manager, know thyself

CJ Brott — Wed, 16 May 2012 13:08:08 +0000

Author: CJ Brott, Capital Ideas

Covestor models: Macro Plus Income, ETF Only

Disclosure: Long DVN

I recently read a client letter by Barton Biggs that was very enlightening. Mr. Biggs and I are both macro investors and have both been investing professionally for over 40 years. So much of what he had to say sounded very familiar. The gist of his thinking deals with the two battles all investment managers fight: understanding the investment process and understanding themselves.

In this client letter he dispenses quickly with the investing process itself, instead focusing on a detailed discussion of the destructive power market swings have on a manager’s investment psychology.

He describes briefly the ongoing battle to hold long term positions in an increasingly volatile market and ends with a warning about the value of understanding the effect of one’s emotions on their actions.

The most important takeaway is that investment psychology has never been more important. In today’s world central banking credit policies are creating an atmosphere far more prone to bubbles and panics than any time in our investment careers.

Combine the extreme volatility created by momentum traders with client focus on short term results and any manager focused on value or the longer term will occasionally question his own sanity.

This is where deep understanding and certainty of your investment thesis and the facts it is based on triumph over panic or euphoria. Our current portfolios contain several examples of this type of investment circumstance, one where our sanity may be brought into question.

Our macro portfolio contains Radio Shack (RSH). This may be one of the most hated stocks on Wall Street. Currently the short term momentum traders seem to feel it can only go lower. As a result, they have established a short position of a size large enough that the stock has become difficult to borrow.

With plenty of free cash flow, a current dividend of $0.50 per year, and an expansion plan both here and in Asia, and Radio Shack may yet work out of their problems. Although owning it will bring a manager many a derisive comment, the stock seems to represent decent value with a better than even chance to turn itself around.

Another controversial idea is the process of “fracking” as it pertains to oil and gas exploration. Applying it as a macro idea we bought two stocks, Devon Energy (DVN) and Chesapeake Granite Wash Trust (CHKR). While we still hold Devon, believing it to be worth much more, we sold CHKR as it exceeded what we believed to be its fair value.

This is another example of psychological control. While momentum traders drove Chesapeake Granite quickly from $18.50 to $30.24 it would have been easy to succumb to the euphoria and fail to liquidate the stock.

However part of the investment process is the constant reexamination of one’s investment thesis. Upon continuing examination of the CHKR hedge positions it became apparent that I was wrong to continue holding the stock.

This is a great example of the investment process helping control the psychological urge to become euphoric as investment ideas work out. And it is that fundamental examination which allows me to keep Devon Energy, despite the popular idea that natural gas prices will decline forever.

Obviously, I was impressed with the discussion of the psychological aspects of investing Mr. Biggs included in his recent client letter. He is right: The pressure to give up and join the crowd during these volatile times is immense. Central banks will continue to increase credit, increasing the probability of higher economic and market volatility.

In this new world knowledge gained from experience will be invaluable. And that knowledge is not just the ability to analyze securities and understand economies but knowledge of your own psychological strengths and weaknesses. Age and experience have helped me tame the animal spirit, but knowledge of how I react to market stimulus will continue to grow.

Defensive stocks are on a tear

Michael Tarsala — Tue, 15 May 2012 19:15:41 +0000

by Michael Tarsala, CMT

Yowza, market participants are risk averse!

Defensive names are dominating the short list of stocks that are still holding up just fine right now.

Using a mix of screeners including one at ramprt.com and getstockideas.com, I looked for stocks that still had this going for them:

Positive price momentum
Still trading above their 50-day moving averages
Market caps of $5 billion and above

I pumped out a list of 66 U.S.-listed stocks, a very small number out of a potential list of 980 (7%).

From that short list, 94% (61 out of the 65) were defensive plays or from defensive groups. Lots of utilities were on the list, as well as consumer staples, biotech and pharma stocks, REITS and some tobacco plays.

For reference, I dumped the short list of tickers at the bottom of this post.

Out of the four non-defensive stocks still on the list, three were alcohol-related, which I consider a quasi-defensive industry group. People tend to drink in good times and bad. When the going gets tough, they'll switch to beer, wine or the cheap stuff. So it was no surprise to see Anheuser-Busch/InBev (BUD) on the list. Yet Beam Inc. (BEAM) and Brown-Forman (BF-B) also were there, as they continue to benefit from a long-term shift toward booze drinking relative to beer and wine.

Polaris Industries (PII) is one of two non-defensive stocks out of the initial screen of 980. Hooray for quads and snowmobiles (which otherwise wouldn't mix with booze). The other is Transdigm (TDG), maker of aircraft components.

This defensive posture is not likely to turn on a time. Yet for me, finding only two decent-sized risk-on stocks that are still chugging along is a contrarian signal. It may be a reason for investors with a long-term horizon to start doing more homework in the risk-on sectors.

A few other things to keep in mind:

The McClellan Oscillator (one I depend on) is at -63; readings below 0 are oversold, and I find readings below -100 to be VERY oversold.
Read the latest from Liz Ann Sonders today, on why this pullback might not be as bad as 2010 and 2011.
More near-term market downside is possible, although it may be time to start looking in the scary places for value.

List of 66:

MNST, GILD, BIIB, REGN, CHD, PII, AGNC, WEC, ORLY, KMB, NEE, AMT, WRB, SRE, SPG, KO, TDG, HCP, NGG, NI, CB, GGP, CMS, XEL, BF.B, WFM, MAC, PGN, EIX, AMGN, SCG, ESS, HCN, DLTR, PNW, LLY, DUK, FRT, ROST, O, VTR, PFE, OGE, ABT, OKE, ACE, D, CL, BEAM, ACGL, VNQ, AVB, DTE, ED, KFT, MO, AEE, SO, KOF, CINF, DG, KIM, CVS, CPN, BUD, GSK

Why a summer rally is possible

Michael Tarsala — Tue, 15 May 2012 16:30:05 +0000

by Michael Tarsala

The ongoing stock market selloff should be less harsh than in the past two years, says Liz Ann Sonders, Schwab's chief investment strategist.

You can read her latest strategy update here.

Here's a cheat sheet:

-- A Q2 selloff could set the stage for a summer rally.

-- Sell in May doesn't work well in election years: The Dow has been up 4.5% in May through October in election years and up 2.6% during those months for all years.

-- Schwab has maintained its "outperform" rating on technology stocks.

-- And despite a strong performance in most May-October periods, it has an "underperform" rating on utilities.

Perhaps more importantly, there are more positive market influences than at this time the past two years, including:

An improving housing market
Falling commodity prices
A strong manufacturing sector
Strong consumer credit growth
Improved jobs numbers
Less leverage in the private sector
More state and local government spending
Low valuations on forward earnings
Investor pessimism is back (a contrarian indicator)

Also read Covestor's Smarter Investing posts for additional market insights, including why the best reason for optimism is pessimism, stock market cues that may come from silver and gold, and why we are probably not starting another major correction.

Size matters in investing: Smaller can be better

Michael Tarsala — Tue, 15 May 2012 15:16:26 +0000

by Michael Tarsala

Bond king Bill Gross shows that when it comes to investing, smaller can definitely be better.

As Investment News explains, the $800 million Pimco Total Return ETF (BOND) is up 300 bps versus the $258 bln Pimco Total Return Fund since the former launched to much fanfare at the beginning of March. The two were supposed to have very similar performance. And they don't.

The reason is simple: It's easier to be nimble and opportunistic in a smaller portfolio than it is a large one.

Size! It's one of the few advantages that small account holders can have over the big boys.

Warren Buffett said as much in 1999, lamenting that he could generate huge 50% returns if only he had less money to invest.

What he meant is that it can be hard to generate strong returns with large pots of money for two reasons:

One, the fastest-growing companies often are the small ones. But because they are so small, it's not worth the time for large accounts to do the research on them. Those stocks won't even move the needle in most large portfolios.

Second, small accounts make it easier to be opportunistic. It often takes many days -- and sometimes much longer -- for large account managers to accumulate positions. Smaller accounts have the luxury of building positions more quickly. And they can also be more opportunistic shoppers.

Small size, by the way, is an advantage in the majority of Covestor's 180 different investment models.

If you'd like to learn more or to simply talk about your investing goals, contact us. We like to talk!

Think about this before buying the Facebook IPO

Michael Tarsala — Tue, 15 May 2012 14:38:02 +0000

by Michael Tarsala

Facebook at its IPO is probably not a stock for most long-term investors to buy:

It's not a core holding for retirees -- some of whom are reported to be clamoring for it.
You don't bet your kid's entire college fund on it (or any one stock).
Given the 41 times forward PE, more than 3x the broad market's valuation, it's not for value investors.

As with any IPO, the short track record means it offers very little in terms of a research edge.

Keep in mind, it's something you may eventually own a decent amount of in your large-cap fund, ETF or growth fund anyway.

Questions long-term investors should be asking include:

Does Facebook deserve twice the market value as Nike (NKE) and Goldman Sachs (GS)?
Is it instantly worth more than Amazon (AMZN) and its more than $50 bln in revenue?
And is it worth more than eBay (EBAY), Yahoo (YHOO) LinkedIn (LNKD) and Groupon (GRPN) combined?

That's possible at the start. It could be worth far more on a market cap basis if there's a big opening day pop.

Yet some experts are skeptical about the long-term.

Henry Blodget was vilified more than a decade ago for giving wildly aggressive tech stock prognostications. He's now calling Facebook "muppet bait," noting cash flow that has turned negative, and 45% revenue growth that is slowing down.

You have to applaud Mark Zuckerberg and Facebook for building such a unique and innovative company that started out of a dorm room. But you don't have to run out and buy this stock. And especially not on the first day.

Protective stop analysis for our Select Equity model

AlphaLab Capital — Tue, 15 May 2012 14:15:54 +0000

Author: AlphaLab Capital

Covestor model: Select Equity

The recent market weakness has focused my attention on the protective stops we use in the Select Equity model. Ever since my first trade, I’ve been interested in how one properly determines a stop loss level. After all, "cut your losers quick and let your winners run" was one of the mantras drilled into my head from other traders. I've tried using average true range (ATR) multiples, moving average convergences, and historical resistance levels. Regardless of method, I was never satisfied with the result. Too often I would watch a stock trade down to my stop loss level just to reverse to the upside and start a new leg higher.

For those of you who don’t know, I’m a system based trader. I have a system that tells me what to buy, when to buy, how much to buy, and when to sell. Using a trading system such as this allows me to collect and analyze data most discretionary traders probably don’t track. For example, since each trade in my system has a distinct holding period, I can monitor the price action for each stock and develop rules around establishing stop loss levels.

When it comes to determining stop loss levels, the most obvious metric to track is holding period low versus the trades resulting gain or loss. Below is a graph showing all the trades for my Select Equity Model from 2010 to date (597 trades in total) with the holding period low on the y-axis and the trades' resulting gain or loss on the x-axis: